Nonprofit Organizations: “Watch Your Step” with the IRS

By Margaret Christiano

Exemption from paying income tax and the ability of donors to deduct contributions are a few of the benefits granted by the IRS to those organizations that qualify for exempt status under Internal Revenue Code section 501(c)(3). However, and while it may be reasonable to wonder if this is the case given the media coverage of certain high profile cases, these benefits require strict adherence to very stringent rules.

Failure to comply with such rules could result in the organization losing their tax exempt status. This could result in the organization having to file income tax returns and pay income taxes, and/or the IRS disallowing contributions by its donors.

Don’t jeopardize your tax-exempt status by committing any of the following five “major missteps.”

1. Violating standards governing private benefit and inurement – 501(c)(3) nonprofit organizations must serve the public interest and are prohibited from performing activities that substantially benefit private individuals or organizations. Reasonable payments for services, including salaries, and payments of fair market value for purchases of goods or other property are allowable. While private benefits to a non-insider must be substantial in order to jeopardize tax-exempt status, the term “inurement” applies the same concept more strictly to individuals who are deemed to be insiders. An insider is someone with a personal or private interest in the activities of the organization, for example, an officer or board member. Any amount of inurement to an insider is grounds for loss of tax-exempt status. As such, transactions with private individuals and/or insiders should be scrutinized to ensure that the organization is not unduly benefitting them.

2. Engaging in substantial lobbying activities – Excessive lobbying activities (i.e. intending to influence legislation) by a 501(c)(3) organization jeopardizes the organization’s tax-exempt status. An organization will be regarded as attempting to influence legislation if it contacts, or urges the public to contact, members or employees of a legislative body for the purpose of proposing, supporting or opposing legislation, or if the organization advocates the adoption or rejection of legislation. While the IRS generally bases its determination on the specific facts and circumstances of each case, an organization may elect to have the determination made on the basis of the relative amount of lobbying expenditures. Either way, an organization found to have engaged in excessive lobbying is at risk, so tread carefully when lobbying is a consideration.

3. Participating in political campaigns – All 501(c)(3) organizations are prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of or in opposition to any candidate for elective public office, including public statements that favor one candidate and/or making political campaign contributions. However, certain activities or expenditures may not be prohibited depending on the specific facts and circumstances. For example, voter education/registration drives are permitted provided they are conducted in a non-partisan manner. Activities such as hosting political candidates as event speakers and publicly advocating positions on public policy issues are allowable assuming compliance with very strict guidelines. Organizations should be extremely wary of most activities related to political campaigns.

4. Failing to satisfy reporting obligations – Most tax-exempt organizations, other than churches, must file an annual return with the IRS (generally, Form 990). If an organization does not file as required for three consecutive years, it automatically loses its tax-exempt status. In order to regain its tax-exemption, the organization must reapply by filing form 1023 and paying a user fee.

5. Incurring excessive amounts of unrelated business income – Unrelated business income, or “UBI”, is income that results from “a regularly carried on trade or business that is not substantially related to the organization’s exempt purpose.” This means that it results from an activity that is not important to furthering the primary purpose of the organization, other than generating income to fund its activities. Common examples of UBI include advertising revenue, rental income and merchandise sales. UBI is allowable to the extent that the unrelated business activities are not a substantial part of the organization’s activities, although such income is taxable. There are no specified tests to determine if UBI is “substantial”; rather the IRS looks at an organization’s primary purpose and the relative amount of time and resources devoted to the unrelated business activities. Therefore, the organization must be careful that such activities remain incidental to their primary exempt purpose.

There can be many bumps in the road for nonprofit organizations, some of which can be major barriers to a healthy future and long life performing the exempt purpose for which they were formed. Organizations can avoid tripping over these obstacles by careful adherence to IRS regulations. The IRS makes various publications which are excellent guides for nonprofit management available on their website. Examples include Tax-Exempt Status for Your Organization and the Compliance Guide for 501(c)(3) Public Charities. These guides and other information are readily available on the web at http://www.irs.gov/charities/.

About the Author
During the period of her employ with Kingery & Crouse, Margaret Christiano, CPA served various not for profit entities.  Previously she also served as the Assistant Finance Director for a local municipality.  Kingery & Crouse, P.A. is a full service public accounting firm with a staff of dedicated professionals providing audit (including SEC), tax and accounting services.  Please contact Lori Rodriguez at (813) 874-1280 (ext 229) or find us on the web @ www.tampacpa.com if you have any questions about the article.